Never waste a crisis: the unstoppable rise of sovereign wealth funds

28th May 2020  

by Raffaella Bianchi

They don't know crises, they don't have liquidity problems, they can go as far as to make investments where the economic return is only secondary: sovereign wealth funds (or SWF), among the institutional actors, are those that have most often conquered the financial headlines in recent years. Considered among the most reliable financial actors in circulation, their aims and strategies vary from country to country depending on the resources available and the economies present. For example, commodity-based economies - such as Chile, Mongolia, Algeria - have set up stabilisation funds to protect their currencies and balance sheets from the high volatility of the underlying markets. In Japan, on the other hand, the priority is to provide for the welfare of its citizens in view of an ageing population by managing surpluses in large pension funds. Particularly oil-rich nations, such as Norway and the Persian Gulf states, not only seek to protect themselves from oil fluctuations, but also diversify their portfolios and bring wealth to future generations in anticipation of when oil stocks will run out.

The real turning point came in 2016 with the occurrence of two unexpected political events - the vote in favour of Brexit and the election of US President Trump - which had a global impact on financial markets and geopolitical relations, with the consequent fall of oil prices and other commodities’ valuations. Since then, SWFs have had to adapt their investment line to new diversification strategies to overturn national economies.

From the outset, SWFs in emerging countries have been the most active by making more domestic investments: to counteract the pressures arising from oil price fluctuations, to cope with slow economic growth and low yields in traditional sectors. They used capital to support their national economies, which doubled the value of domestic business. This strategy has allowed these markets to grow rapidly and become leaders in technological innovation in recent years.

It is also interesting to remark that although last year's failed IPOs in Uber and WeWork brought great uncertainty and a sharp slowdown in investment, sovereign wealth funds do not seem to be discouraged by the current economic situation. "Never waste a crisis. We are therefore looking at all opportunities”, were in fact the words declared last April by Yasir al-Rumayyan, head of the Public Investment Fund (PIF), Saudi Arabia's $325 billion public fund.

While the coronavirus pandemic is unleashing economic carnage around the world, the PIF has intensified its investments to become one of the most active SWFs. This strategy may be necessary in order to reduce the negative impact suffered by the fund due to the huge drop in oil prices. Considering only the investments made public by the fund itself, during the first four months of the year PIF invested around $500 million in Live Nation, a US entertainment company, and acquired 7.3% of Carnival, becoming the second largest shareholder of the world's largest cruise operator. It also invested in about 20 US and European blue-chip companies, such as BP, Boeing, Citigroup, Disney and Facebook, acquiring shares worth about $7.7 billion. All this is made possible thanks to the fund structure itself: the PIF is in fact divided into units, which means that losses in any investment segment do not have an excessive impact on the entire business.

Like the PIF, other Gulf investment funds are looking for investments at a reduced price (a strategy already adopted during the 2008-09 financial crisis). Although the timing does not seem to be the most propitious, strategically the goal is to expand their portfolio into categories that are currently blocked by the crisis (thereby under-paying their shares), but which will bring important returns once the economy opens up again. The strength is based on the breadth of the funds themselves, which allows infinite synergies between the fund and the portfolio companies. There is therefore a patient and forward-looking strategy in which many of these companies are expected to become market leaders in their sector over the next few years.

Even countries worst hit by the crisis in recent months are planning to open their own sovereign wealth funds, not only to enrich their portfolios, but above all to be able to cope with the current situation, once the economy "resumes" its natural course. In recent days, the British government has indeed proposed that the credit granted to small and medium-sized enterprises to help the economic recovery be converted into state shares and transferred to a national sovereign fund. With such low long-term government borrowing costs, the cost of debt maintenance would be negligible, while once the economy recovers, debt service would be more than covered by the return on new capital.

There are certainly big questions lingering about the outcome of these bets. Right now the PIF and the large SWFs are a reference point for entities that need capital, allowing large amounts of money that privately would be more difficult to raise. However, it is inevitable to wonder whether, at a time of great uncertainty and frailty, it is appropriate and strategic for SWFs to invest in the volatile ecosystem of the VC, given that the losses resulting from previous investments have been substantial. In fact, the Vision Fund reported a loss of $17.7 billion at the close of the fiscal year (in March 2020) with the consequent devaluation of 47 of its 88 holdings. Nevertheless, it should not be forgotten that following the financial crisis of 2008-09 with interest rates at historic lows and particularly slow global economic growth, the strategic change in governments' use of liquid and illiquid resources has led to the creation of sovereign wealth funds with a positive and rapid recovery in domestic growth and global economic development. Only time will therefore show us whether this strategy will prove successful once again, bringing to light those rough diamonds that have been underpaid to date.